The UK has historically been a very attractive jurisdiction for international real estate investment. One of the factors behind this has been a relatively benign tax regime.
However, from April 2019, overseas investors in UK real estate will find they are subject to a new tax charge. In a move that has been described by the UK government as “levelling the playing field” between domestic and overseas owners of UK property, capital gains tax will apply to disposals of UK real estate by non-residents.
The timing so close to the UK’s withdrawal from the EU (March 29, 2019) has been questioned. Arguably, the UK is merely playing catch-up with other major jurisdictions that already exert similar taxing powers, prevalent across many European jurisdictions and the US.
Importantly, the charge will only apply to gains that accrue after April 2019. To protect against the charge applying to historic gains, investors will be able to “rebase” the cost of their asset to the market value as of April 2019.
The new tax provisions will apply to both direct and indirect disposals of interests in UK real estate. The charge on indirect disposals means that the sale of shares in a company (or other vehicle) that is “property rich” will be taxable. So, it will not be possible to avoid the charge by selling the holding vehicle rather than the underlying property.
The definition of a property rich entity for indirect disposals means at least 75 per cent of the entity’s value is ultimately derived from UK land. The test is conducted at the time of disposal and will present challenges where vehicles hold assets in other jurisdictions as well as the UK.
These entities may dip in and out of being “property rich” as values and market conditions in different jurisdictions fluctuate, leading to uncertainty over investors’ tax position. Anti-avoidance rules have been proposed to combat artificial manipulation of a company’s balance sheet to meet this test.
There are two exemptions from the charge for indirect disposals of interests in UK real estate:
* The ownership exemption
Overseas investors holding less than 25 per cent interest in a property rich vehicle are excluded from the charge, provided their stake has been under 25 per cent for the two years leading up to their disposal.
When calculating whether an investor meets the 25 per cent test, interests held by connected parties are aggregated. So if a husband and wife between them hold over 25 per cent of a property rich vehicle they will be caught by the charge. Similarly, minority investors in joint ventures and “club” deals are also likely to be caught.
* The trading exemption
If the entity uses the UK property in a trade, overseas investors will also fall outside the new tax charge. This exemption is designed to ensure that the rules do not bite real estate heavy trades by retail and hotel groups. There are various conditions that must be met to fall within this exemption, and some groups will need to restructure to ensure they qualify.
A continuing source of uncertainty relates to the treatment of UK real estate funds using non-UK holding vehicles, such as Luxembourg companies or Jersey unit trusts. As it stands, the new regime could leave investors in a worse tax position than they would be in if they held real estate assets directly, and make investment in the sector via funds and joint ventures less attractive.
The good news is that the UK government has been receptive to these concerns and is continuing to consult with industry bodies on how the rules can be tailored. It remains to be seen what effect these new rules will have on the attractiveness of the UK as a jurisdiction for real estate investment.
Steps overseas investors should take now to prepare:
• Investors should review their property portfolio to determine if they have an interest in a UK property rich entity.
• If a disposal is anticipated after April 2019, a valuation will need to be undertaken to determine the impact of rebasing.
• Going forward, the new rules will be a significant factor when deciding what holding vehicle should be used by investors and funds acquiring UK real estate.
• Investors and fund managers will need to monitor closely the ongoing consultation on the special regimes for fund entities. Funds may need to restructure prior to next April to ensure that they qualify.
— Kirsten Prichard Jones is Senior Counsel at Macfarlanes. Rhiannon Kinghall Were is Head of Tax Policy at the firm.
Source: Gulf News
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